Budget cuts must be gradual, OECD warns

TREASURER Joe Hockey has been warned to avoid "heavy front loading" his federal budget cuts while faced with a sluggish economy and an unemployment rate set to peak above six per cent.

The Australian economy continues to face near-term uncertainties as the resources investment boom unwinds and non-mining businesses show reluctance to expand, the Organisation for Economic Cooperation and Development believes.

In its Economic Outlook on Tuesday, the Paris-based institution expects the economy to grow at just 2.6 per cent in 2014, well below its long-term average of about 3.25 per cent.

It has cut its 2015 growth forecast to 2.9 per cent from 3.1 per cent six months ago.

The shift away from resource sector investment will mean comparatively low employment growth, with unemployment peaking above six per cent, the OECD says.

The jobless rate unexpectedly dipped to 5.8 per cent in March after hitting 6.1 per cent in February, its highest level in more than a decade.

The OECD does not expect unemployment to show real improvement until the second half of 2015.

As such, it says the treasurer's approach to returning to a surplus should be gradual.

To reach his objective of a budget surplus of one per cent of gross domestic product (GDP) by 2023/24, and taking into account spending commitments already in the pipeline, would require a deficit reduction of about half a percentage point of GDP each year, it says.

That would be about $6 billion a year.

Some of this deficit reduction will happen automatically as economic growth picks up and if bracket creep is allowed to operate; that is, wage inflation taking an individual's salary into a higher tax bracket.

The OECD says subdued inflation pressures will allow the Reserve Bank to keep interest rates low for now and support a continued economic recovery.

However, rapid growth in house prices and mortgage lending "requires continued close attention".

The central bank on Tuesday left the cash rate at a record low of 2.5 per cent, where it has stood since August 2013.

The OECD believes the central bank should start raising interest rates in the first half of 2015.